Chances are, you could find an ETF that seems as though it was tailor made for you. And much like the mutual funds did when they were proliferating, new ETFs are appearing all the time from a combination of factors – chiefly, consumer demand and whatever is the latest, hottest sector.
What makes them so attractive to investors?
• They’re served up in a basket. Like mutual funds, ETFs pool various securities – stocks, bonds, commodities, currencies – into one package. Most often these packets are reflected by an index that represents a large group of investments. The Standard & Poor’s 500 index represents the 500 largest stocks by market value, for example. This basket is then treated like an individual security and listed on an exchange. Constantly creating and redeeming shares “in-kind,” ETFs exchange shares for pools of underlying securities.
• They make trading easy. As separate, listed securities, ETFs trade just like stocks. You can buy and sell them through brokers, and they are traded throughout the day. Their prices constantly reflect changes in market prices. They are different from open-ended mutual funds, in which investors buy shares in a pool of securities. Mutual funds are not listed on exchanges. When you purchase shares in an open-ended mutual fund, new shares are created. With ETFs, you buy them the same way you would a stock, using techniques such as shorting (selling in anticipation of a price drop), limit-buys, and stop-loss orders. You can also write options – both calls and puts – against ETFs. You can’t do that with mutual funds.
• You know what you’re buying. ETF managers publish their holdings every day and note any changes. Most portfolios that represent an index rarely change at all. You know what you own at all times. What you see is what you get. That’s not possible with an open-end, actively traded mutual fund, which only has to publish quarterly statements and won’t fully disclose its trading expenses. As such, ETFs are not subject to the kind of trading abuses that have ravaged mutual funds in the last decade. Exchange traded funds are continuously repriced throughout the trading day, so late trading isn’t possible. In comparison, the net asset value (NAV) of traditional mutual funds is always a trading day’s closing price.
• Their cost is very low. Because there’s little in the way of trading costs – holdings in index ETFs are rarely sold[md]management fees are low. Although you’ll pay a brokerage commission to buy or sell them (we recommend working with a deep-discount broker), expenses are minimal in ETFs because they are efficient. Considering that the average actively managed stock mutual fund charges you 1.50 percent per year in management expenses, the savings are significant, according to Morningstar, Inc., the Chicago-based financial information company. The average U.S. stock ETF charges .41 percent annually.
• They’re tax friendly. If an actively managed, open-end mutual fund has a good year, you’ll often pay for it in taxable gains outside of a tax-deferred account. Not so in most ETFs, which are largely insulated from the need to sell holdings for shareholder redemptions. Most index ETFs have static portfolios that are passively managed, so they generate gains only if a security needs to be sold because the index keepers have changed the index. So most ETFs don’t generate capital gains from buying and selling components; you pay tax only on profits from selling your ETF shares, meaning that you also control the timing of taxable outcomes.
• They help you diversify and reduce risk. Because ETFs are broad baskets of securities, they can represent entire markets. Want to buy a fund representing all listed U.S. or foreign stocks? How about sampling most large overseas stocks? Or U.S. bonds? ETFs can do that and more. By giving you exposure to more securities, they lower your portfolio risk. You need never buy another single stock or actively managed mutual fund again. Why gamble far too much money on what you think will be the next Google when you can buy an entire fund full of potential winners from all over the world?
Investors around the world are eager to learn all they can about ETFs and figure out how they can take matters into their own hands with these innovative and exciting funds. Stick with us, and we’ll show you how.